FOR most business owners, business interest tends to form a very major part of their overall assets value.
As such, comprehensive estate planning would be incomplete without consideration on how you can ensure that your interest in business is properly protected and smoothly transferred to your heirs in its highest value.
Business succession planning goes beyond just writing a will to make your wishes come true. There is a popular old saying that professes “businesses and wealth will not survive more than three generations”.
Most of the time it is due to personal conflicts and no proper comprehensive financial and estate planning.
Your business interest is not unlike investments in the stock market. The only difference is that in the stock market, you invest in other people’s companies whereas with yours, you invest in your own companies. If we can spend time and effort in getting the best investments in the stock market, it would only be rational to spend time and effort in ensuring that the investments in our own companies are in order and give the best values to our heirs.
Proper planning for business interest is not only important for its monetary value. In most cases, a business represents a business owner’s lifetime efforts and success. A smooth transition and succession of business can instil confidence in other stakeholders such as the employees, suppliers and customers. With proper planning for business interest as death, one can ensure that his lifetime effort and success will continue to prosper in his absence.
However, protecting and distributing business interest through estate planning is not as straightforward as that for other assets. For assets like fixed deposits, CDS accounts or unit trusts, beneficiaries can be named in the will, and they will enjoy the benefits quite easily. The full value of a business interest is not so easily or fully realised. Getting fair value out of the business is challenging enough when there is time to plan and exit during lifetime. In the case of death, it is worse because it removes the most critical element from the planning process — time.
Types of business interests
There are three types of business ownership in Malaysia namely sole proprietorship, partnership and corporation.
It is important to understand clearly the differences between the types of business interest as each has different legal implications at the owner’s death. A sole proprietorship is a business owned and operated by one person. It is a business entity of which existence is not separated from the owner. As such, the death of the owner also means the termination of the business. The business interest is not passed immediately to the heirs. It has to undergo a long and tedious process of administration or probate.
Case study — Mr Lee, who was in his late 30s, owned a successful accounting practice as a sole proprietor with a staff of six non-professionals. Although the business’ monthly overheads were as high as RM40,000, he could easily draw RM20,000 per month from his practice. Mr Lee was a sole proprietor without any partner in the business. He asked his wife to stop working as a secretary so that she could spend more time with their children. One day, while driving to Sibu, Mr Lee was hit by a lorry and was killed instantly. His death brought tremendous financial problems to his family.
Clients who needed accounting and taxation services switched to other accountants after Mr Lee’s death. Sadly, he had outstanding house mortgages without a mortgage cancellation insurance policy.
He only owned a RM50,OOO policy without the beneficiary named. Upon his sudden death, all his personal and business accounts were frozen and his staff unable to receive their salaries for a few months pending personal estate clearance. With fewer clients, the business’ income shrank and there were difficulties in paying overheads. His wife, not being an accountant, was not qualified to continue the business. She tried to sell it to other accountants but no one was interested.
As Mr Lee was the family’s sole breadwinner, there was no other income for his family. His personal savings could only last the family for eight months. What could Mr Lee have done to avoid this unfortunate tragedy?
Alternatives for disposal
When the sole proprietor dies, the heirs can choose one of the following alternatives to dispose of the business interest:
·The estate administrator or executor liquidates the business
·Unless authorised by the will or court order, the administrator or executor continues the business until it can be sold as going concern. In this option, the sole proprietor’s will give the power to the administrator or executor to continue the business and exempt him from personal liabilities for the appropriate actions taken during this period.
However, the administrator or executor may still be liable for any losses caused by his negligence or imprudence. A few difficulties are foreseeable during this period.
Firstly, the administrator or executor may not be experienced or familiar enough to run the business operation.
Secondly, after selling the outstanding estate liabilities, administration expenses and taxes, the administrator or executor may not have sufficient working capital to continue the business. To successfully sell off the business as a going concern, the administrator or executor has to overcome these two major challenges.
·The heirs inherit the business through the sole proprietor’s will.
In the sole proprietor’s will, the business can be transferred to the heirs as a gift. However, the heirs may not have sufficient knowledge or ability to run the business profitably. If they are not successful, they may dispose of their other estate inheritance in order to save the business. As such, the business gift may turn out to be a liability rather than an assets for the heirs.
·Sale of the business by an agreement prior to the sole proprietor’s death.
Before his death, the sole proprietor can offer the sale of his business to his employee or an interested outsider. With this option, the potential buyer enters into a contractual agreement with the sole proprietor binds his estate for sale and the buyer to buy the business at an agreed price.
·Proper assessment of business value in comprehensive estate planning.
Among the three business forms, sole proprietorship is the most difficult to sell. It is a challenge to place a proper value on a sole proprietorship business due to lack of market and automatic winding-up death.
As such, it is important not to overestimate the value of the business in your estate planning because it may underestimate the cash flow needs at death. Due to the different nature of business value, it is important to have a competent estate planner to help assess your business value, as he would be able to highlight the probable shrink-age in its value under different circumstances.
·Update your will to give your executor the power to continue or sell the business.
This extra flexibility would provide more options in deciding what is best for the heirs. Without the power or instruction, the executor is not likely to try anything other than winding up the business as soon as possible. This is due to the fact that the executor is bound by law to protect the assets in the estate. If the heirs are interested in continuing the business, you may want to instruct the executor to transfer the business to then
·Look for a successor owner in key employees.
·As an alternative it is important for the sole proprietor to put in some effort in identifying potential successors and preparing them to take over the business one day. Get the prospective successor involved in the day-to-day operations to give him the exposure and needed experience. You can enter into a contractual agreement with him to buy over the business after your death. You may even want to sell your business to him when you want to retire.
·Look for potential buyers among professional friends.
For some professional practice like land surveyors, architects and consulting engineers, sole proprietor can actually look for another friendly professional to enter into a buy and sell agreement. Such an agreement will ensure that any surviving professional will purchase the practice from the deceased professional’s estate at an agreed and fair price. This solution helps to cushion the financial impact of all the above mentioned alternatives.
·Liquidate the business.
·Unlike a partnership of corporation that has other partners or shareholders in interest, a sole proprietorship’s heirs may not realise much value from the liquidation of the business. Under forced liquidation, a loss of 40% to 90% is not uncommon. Some even face liabilities in excess of the liquidation value of the assets. Life insurance helps to compensate the estate for the losses in the business value. It guarantees your family an adequate income irrespective of the success or failure of liquidation or transfer of the business.
·Continuing the business until it can be sold as ongoing concern.
Besides settling outstanding estate liabilities, a funded buy-sell agreement provides sufficient working capital during the transition period to buy time for the executor/administrator.
·Heirs inheriting the business through the sole proprietor’s will.
A funded buy-sell agreement provides the working capital for the heirs to learn the trade and compensate for the mistakes during the transaction period. It gives a better chance of proper succession of sole proprietorship business.
·Sale of the business by a buy-sale agreement prior to death.
Even if there is a contractual agreement binding the buyer to purchase the business, the buyer may not leave the necessary funds to settle the purchase price when the business owner is dead.
As such, the interested buyer can purchase life insurance an the life of the sole proprietor, which will provide the funds needed for the purchase of the business when the time comes. A similar approach can be adopted for partnerships and corporations.
Question and answers
What if I have no beneficiary to give to?
You may wish to consider paying back to society by giving to your favourite cause, such as education, medical research, charity or religious body of your choice.
Why do I need to when I do not have many assets anyway?
It is all relative. Regardless of the value of your assets, they are important to your loved ones especially those who depend on you.
Writing a Will is about creating a legacy of love and protecting the little treasures you have. You can also decide the beneficiaries of your choice, when to benefit them and how much to benefit them.
Moreover, over the years your assets may grow and our will can cover future acquired assets as well as future inherited assets without re-writing it if you do not wish to do so. Besides, if you have young children, you can also appoint guardians for them through a will. And writing a will “will” ensure that your beneficiaries can inherit your estate sooner.
What if I have more liabilities than assets?
Although this may be the present situation, over the years, you would have accumulated more assets and you would still need a will to distribute them. Since a will is only effective upon death, your existing will would still serve its purpose of determining your estate distribution.
>Wealth Advisors specialises in estate planning and financial planning in association with Rockwills Corporation Sdn Bhd & As Salihin Trustee Bhd.
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>There will be a Business Opportunity Presentation as A Professional Estate Planner at 5pm and a Customer Educational Talk on The Importance of Will and Trusts at 7pm at Kingwood Inn in Kuching on Dec 5. Limited seats are available.
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